SEC may tilt exchange boards

Proposal would give more power to independents

November 10, 2004|By Andrew Countryman, Tribune staff reporter.

Federal regulators on Tuesday took a step to revamp the governance of securities exchanges, including the Chicago Stock Exchange and the Chicago Board Options Exchange, with a proposal that could lessen the clout of their members.

The plan, proposed in a 5-0 vote by the Securities and Exchange Commission, would require exchanges to have a majority of independent directors on their boards and a series of committees staffed only with independent directors. Members of the exchanges, who make up large chunks of their boards, would not qualify as independents, SEC officials said.

The plan, which comes in the wake of the scandals that exposed governance shortcomings at the New York Stock Exchange, is far from final.

The proposal, which also would require enhanced financial disclosure from the exchanges, now goes to a 45-day public comment period, and SEC Chairman William Donaldson said any final rules would most likely not face a vote until after the first of the year.

If the plan is approved, it would mean a shake-up on the boards of the Chicago exchanges, particularly in their committee makeup.

At the Chicago Stock Exchange, its 50-50 split between members and independent directors would have to be tipped toward the independents, and some committees will need to shed member representatives.

The SEC also moved to require separation of regulatory and business functions at the exchanges either via a complete delinking, as at the Nasdaq stock market, or having regulators report to a fully independent board panel, as at the NYSE.

Chicago Stock Exchange Chief Executive David Herron said shifting the board's makeup "isn't the end of the world--we can do that." But he wondered about the wisdom of eliminating the expertise of member directors from exchanges' nominating, governance, audit, compensation and regulatory oversight committees, as would be required under the SEC plan.

"We think it's important to get the input of the actual customers," he said. "I don't know how you can say the customers shouldn't have a say in how the business is run."

The CBOE already meets the SEC's proposal with a regulatory oversight committee made up of independent directors, but it is just under 50 percent independent members and also would have to adjust the membership of other panels.

"The truth is, the members offer some valuable insight," said CBOE Chairman and CEO William Brodsky. "I don't know what the problem is they're trying to solve, unless it's pure optics."

Grasso, NYSE specialists probed

The rule proposal was prompted in large measure by the controversy over former NYSE Chairman Richard Grasso's $188 million pay package and by a probe into improper trading by its specialists, who match buy and sell orders on the floor of the exchange, that resulted in more than $240 million in penalties. Grasso resigned under fire last year.

The SEC proposal would also require periodic reports--at least annually on finances, governance and charitable donations, and quarterly on regulatory matters--that would include the compensation of top executives.

"Our present ... system is not working adequately," said SEC Commissioner Harvey Goldschmid. "`Appalling' is the word for some of what we found."

But the Chicago Stock Exchange's Herron stressed that these transgressions were not universal. "Some of the problems they alluded to that triggered this [proposal] didn't happen everywhere," he said.

In response to the Grasso situation, the NYSE created a board with only independent members, plus an advisory panel with floor members and representatives of companies listed on the exchange.

"I don't know if that's the best model. It certainly hasn't had a chance to be tested," Brodsky said.

In addition to the rule proposal, the SEC also sent out for comment a so-called concept release--essentially, a discussion paper--to examine the effectiveness of self-regulatory organizations, known as SROs, in general.

Chairman William Donaldson said while he favors the formal proposal issued Tuesday, "I also believe that broader questions remain as to whether the self-regulatory system, as currently structured, remains the best and most efficient model for overseeing markets and market participants."

Self-regulation reviewed

One idea floated by the SEC is to have a single regulator oversee the exchanges. Herron noted that the SEC already has ultimate authority, and that self-regulation means experts within the exchanges are monitoring activity and are capable of detecting improprieties quickly.

"I think the self-regulatory system works," he said.

"The question is what problem are you trying to solve, and does the solution fit the problem?" Brodsky asked.

But Wall Street's top lobbyist, the Securities Industry Association, applauded reconsideration of self-regulation.

"It is time to determine if our current self-regulatory system offers sufficient checks and balances, or whether a different model would provide a greater level of investor protection and regulatory efficiency," said SIA general counsel Ira Hammerman.